I'm a Fellow at the Adam Smith Institute in London, a writer here and there on this and that and strangely, one of the global experts on the metal scandium, one of the rare earths. An odd thing to be but someone does have to be such and in this flavour of our universe I am. I have written for The Times, Daily Telegraph, Express, Independent, City AM, Wall Street Journal, Philadelphia Inquirer and online for the ASI, IEA, Social Affairs Unit, Spectator, The Guardian, The Register and Techcentralstation. I've also ghosted pieces for several UK politicians in many of the UK papers, including the Daily Sport.

Given that Greg Mankiw is a former Chair of the Council of Economic Advisers this is an excellent question he poses, one that’s well worth answering:

There is one question I would like to see some reporter ask Alan Krueger, the president’s chief economist: How did they decide that $9 per hour is the right level? Why not $10 or $12 or $15 or $20? Presumably, the president’s economic team must believe that the adverse employment effects become sufficiently large at some point that further increases are undesirable. But what calculations led them to decide that $9 strikes the right balance?

That is, a past holder of that job as economic advisor would like to see someone ask the current holder of it to explain the evidence leading to this particular number. And while I’m not even an economist, let alone anyone ever going to be in the running for that type of job, I can provide an answer. Which is that this appears to be around and about the rate at which anything actually happens. A minimum wage below around 45% of average wages seems not to affect anything or anyone very much. One of over 45% or so of average wages appears to have large bad effects and no really noticeable good ones. Thus, given that average hourly wages in the US are around the $20 level at present, a $9 minimum wage would be, around and about, the level at which very little of anything much happens but we don’t therefore have many bad effects.

In more detail, Don Boudreaux runs through the standard objections to a minimum wage. Here and here: everything he says is of course absolutely true. He is Don Boudreaux, after all. However, the question here is not whether those effects exist: it’s how important are they? To which Angus has an answer here. Not very essentially. But that’s not enough of course, what we really want to know is why aren’t the effects going to be all that much?

Clearly, a 90 cent minimum wage would make no darn difference to anyone. 6 year olds get more than that these days for tidying their rooms. So a 90 cent minimum wage would simply be an irrelevance. $90 would lead to the collapse of the economy as everyone whose output was worth than that sum per hour lost their jobs. The question we really want the answer to then is where is the dividing line between irrelevance and catastrophe? And fortunately this has been worked out for us. Worthwhile Canadian Initiative has the details:

The actual state of knowledge of the impact that the minimum wage has on employment in North America, and especially in Québec, leads to the conclusion that a minimum wage that is greater than 50% of the average wage is harmful to small wage earners and that a minimum wage that is less than 45% has very little risk for this group of workers. Between these limits, the area of 45% to 50% would represent an increasing danger to employment.

By all means go through to read the research that led to this conclusion but all we need here is that very conclusion. Now we can look up what average wages are and for the US it appears to be a shade under $20 an hour. $20 x 45% is $9 an hour and there we have it, our justification for why the minimum wage should be $9 an hour. It should be this amount because above this we expect to see increasing and serious effects on employment.

The reason for this is interesting too. The reason there won’t be much effect of a minimum wage at this rate is because hardly anyone actually gets the minimum wage. Yes, I know, we can look up the numbers and see millions being paid it. But once you look a little deeper you see that the numbers become much, much, smaller:

One reason is that very few people actually earn the minimum wage and of those who do, well, it’s something of a chimera that they do. As the Bureau of Labor Statistics tells us:

About three in four workers earning $5.15 or less in 2005 were employed in service occupations, mostly in food preparation and service jobs.

That of course refers to the old minimum wage of course: but there were about 1.9 million workers, or about 2.5 % of all hourly paid workers, who got the minimum wage or below. And most of those in food preparation or service jobs: well, they’re the people getting tips on top of those minimum wages. So this rise in the minimum wage this week might in fact change, to any significant degree, the incomes of perhaps half a million people, which in a country of 300 million and rising really isn’t all that large a number.

The actual figures for minimum wage earners (for 2010) are here. Almost everyone just looks at the totals. Out of 73 million hourly paid people (excluding all the self-employed) some 4.3 million get the minimum wage or less. Well, that’s close to 6% of the relevant labour force (or more like 3% or so of the total labour force including salaried workers). Changing the pay rate of 6% might have some marginal effect on inequality, yes.

But look a little more closely at the figures. Of those at or below minimum wage some 39% are in food prep and related industries. This includes all of your friendly neighborhood waiters and bartenders and we all know absolutely that they’re not living purely on their wages. We rather get reminded of this when we foreigners forget to leave them a tip (I have actually had a waiter in NYC tell me, as I was sitting down, that he had to tell me as a foreigner that a 20% tip was normal). Indeed I’ve done the job myself for a couple of years and no one at all goes into that industry for the joy of the paycheck. It’s the tips that matter and they make minimum wage an irrelevance (I suspect even more than used to be true in the place I worked. The Motley Fool HQ is now across the street which should do wonders for tip income).

Another 17% are in sales and related jobs. Again, no one is doing that sort of work for minimum wage without there being a commission system on top.

Another way of slicing the same numbers is that 50% or so of those on minimum wage are 24 or under: students and trainees in effect.

Changing the wages paid of that over 50% of minimum wage earners who get tips or commission on top of the minimum wage really isn’t going to change inequality very much. Or another way of looking at this is that once you take out those for whom minimum wage is just a basic, before tips and or commissions, we end up talking about 3% or so of hourly paid workers, or something like 1.5% of the total workforce.

The change in the minimum wage is going to be a change in the wages of perhaps 2%, maybe 1.5% of the entire labour force of the whole country. Whatever change there is going to be is therefore going to be confined to this very small subset of the population: and of course not all of them will suffer whatever fate a rise in the minimum wage will cause, only some subset.

Those who will suffer are going to be the young: teenagers specifically. This has been shown again and again. But if everyone’s OK with that well, then everyone’s OK with that. Maybe they should be in school or doing their homework instead of being out earning. I don’t agree but that’s entirely personal opinion.

A couple of more minor points. The Card and Krueger idea that a higher minimum wage will actually increase employment. Umm, no, for reasons laid out here. I’m afraid that the paper just doesn’t show what everyone thinks it does. It shows that there could indeed be a rise in employment in a capital intensive sector when wages rise but that’s very different from what people think it says which is that employment will rise in a labour intensive sector when wages rise.

Another common current thought is that the extra spending will lead to an increase in demand and thus higher employment. The idea is that the poor spend all of their money while the rich and corporations don’t. So, move money from those rich and corporations into the hands of the poor and more, say, some 10 or 15% of the amount moved, will be spent, thus boosting aggregate demand. OK, so let’s assume that this is true. There’s not going to be any discernible effect as a result of this. For look at the numbers again. Something like 2 million people will have their wages boosted by $1.75 an hour. Assume they work 2,000 hours a year, that’s a $7 billion a year rise in the incomes of the poor. Not too shabby: but don’t forget, we expect the rise in aggregate demand to be only the difference in the marginal propensity to save/spend. Say, 15% of that amount. So our actual addition to aggregate demand is, umm, around a billion dollars.

In a $15 trillion economy that’s not actually something we would note. We don’t actually measure the numbers accurately enough to be even able to recognise a $1 billion change in the aggregate economy. Or, take this from one of the studies of the stimulus (and yes, this is one that showed that it worked):

The stimulus created 2 million jobs in its first year, and 3.2 million by March 2011.

OK, for $800 billion or so we got 3.2 million jobs. For $1 billion we’ll get, presumably, one eight hundredth of that: 4,000 jobs? Recall, the employment numbers come with error bars: as I recall it those error bars being 150,000 either way. We simply don’t measure the economy accurately enough for us to ever know whether a rise in the minimum wage would increase aggregate demand enough to increase employment.

So, to answer the original question posed by Professor Mankiw. Why set the minimum wage at $9? Because that’s the rate at which pretty much nothing happens. There’s no major or appreciable effect on employment, either way. Too few people earn the minimum wage for mass unemployment to follow from this rate. Similarly the rate is too low for the extra aggregate demand to have any effect that we’re even capable of measuring. The only real effect would seem to be that teenagers will find it harder to get a job. And thus a $9 minimum wage: it doesn’t actually do anything very much so why not?

Which leaves just two final points. The first is the proposed indexation of the minimum wage. This is, presumably, so that it will just rise in line with inflation and so it won’t be necessary to have great bruising fights over raising it every few years. Sadly, this won’t work for long, for wages generally (although not recently to be sure) rise faster than inflation. The indexation should be to the average wage, not to the general price level. Otherwise the minimum wage will fall behind the average wage again over time.

The other is something I’m not sure about at all. I’ve just not been able to find an answer to it. This 45% limit of average wages. Yes, but which average wage? Do we mean the mean average, in which case $20 per hour is about the right level? Or do we mean the median average wage which is more like $16.50 per hour? In which case at $7.25 the current minimum wage is about as high as we can go before getting those notable bad effects and $9 is more like 54% of average wages in which case we really will see bad effects. As I say, I don’t know the answer to this: but I sure do hope the President’s advisers do.

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